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This paper examines the interaction of G7 real exchange rates with real output and interest rate differentials. Using cointegration methods, we generally find a link between the real exchange rate and the real interest differential. This finding contrasts with the majority of the extant research on the real exchange rate - real interest rate link. We identify a new measure of the equilibrium exchange rate in terms of the permanent component of the real exchange rate that is consistent with the dynamic equilibrium given by the cointegration relation. Furthermore, the presence of cointegration also allows us to identify real, nominal and transitory disturbances with only minimal identifying restrictions. Our findings suggest that persistent deviations of real exchange rates from their equilibrium value can have feedback effects on the underlying fundamentals, hence altering the equilibrium exchange rate itself. This has important implications for the persistence measures of real exchange rates that are reported elsewhere in the literature.

This paper examines to what extent the build-up of "global imbalances" since the mid-1990s can be explained in a purely real open-economy DSGE model in which agents’ perceptions of long-run growth are based on filtering observed changes in productivity. We show that long-run growth estimates based on filtering U.S. productivity data comove strongly with long-horizon survey expectations. By simulating the model in which agents filter data on U.S. productivity growth, we closely match the U.S. current account evolution. Moreover, with household preferences that control the wealth effect on labor supply, we can generate output movements in line with the data. JEL Classification: E13, E32, D83, O40

This paper examines to what extent the build-up of 'global imbalances' since the mid-1990s can be explained in a purely real open-economy DSGE model in which agents' perceptions of long-run growth are based on filtering observed changes in productivity. We show that long-run growth estimates based on filtering U.S. productivity data comove strongly with long-horizon survey expectations. By simulating the model in which agents filter data on U.S. productivity growth, we closely match the U.S. current account evolution. Moreover, with household preferences that control the wealth effect on labor supply, we can generate output movements in line with the data.

Discussions of the international dimension of the global economic crisis have frequently focused on the build-up of large current account "imbalances" since the mid-1990s. This paper examines the extent to which the U.S. current account can be understood in a purely real open-economy DSGE model, were agents' perception of long-run growth evolves over time in response to changes in productivity. We first show that long-run growth forecasts based on ltering actual productivity growth comove strongly with survey measures of expectations. Simulating the model, we nd that including data on U.S. TFP growth and the world real interest rate can, under standard parametrizations of our model, explain the evolution of the U.S. current account quite closely. With household preference that allow positive labor supply e¤ects after favorable news of future income, we can also generate output movements in line with the data.